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A Simple Strategy for a Retirement Paycheck

Someone once said, "Everybody wants to go to Heaven, but
nobody wants to die." Something similar may be true for new
retirees. Everybody wants to stop working, but nobody wants to
give up that paycheck.

For years, workers have been hearing about how important it is to
save as much as possible as early as possible. Americans weren't
saving enough. They weren't investing properly and unless they
changed their evil ways, they were going to work until they died.

It turns out that accumulating retirement assets may have been
the easy part. Spending those assets seems to be a lot harder.
Our bipolar equity markets are unnerving at best and interest
rates are at historic lows. Add the apparent inability of
governments to get their fiscal houses in order and it's little
wonder why retirees are frustrated and maybe a little bit scared.
Now that they have a nest egg, figuring out how to spend it is a
new and challenging obstacle that needs to be solved in order to
enjoy a financially peaceful retirement.

What about annuities?
Immediate annuities provide a stream of income that can't be
outlived. They are the next best thing to the old fashioned
defined benefit pension plans that so many long for. Many
retirees are seeking out annuities to provide the steady reliable
income that they covet. But annuity prices are linked to interest
rates. Recently, a 70-year-old woman asked for an annuity quote
that would pay $2,200 a month for life and 20 years certain. The
insurance company came back with a price of $424,000. If she dies
before age 90, the contract will pay out $528,000. That's a
return of 1.10 percent for 20 years. If she lives to 95, the
contract will pay $660,000 resulting in a 1.79 percent return.
Does anyone want to tie up money for 20 years for a 1.10 percent
return or even 25 years for 1.79 percent? The answer is probably
not. Are immediate annuities still a good retirement vehicle?
Yes, just not right now.

What about the four percent rule?
Some smart people have conducted extensive research to determine
how much a person may draw from retirement assets and have those
assets last through retirement. They looked at historical rates
of return and inflation and made assumptions regarding asset
allocation and the duration of retirement. Without getting into
all of the details, the magic number seems to be about four
percent. In other words, a new retiree can withdraw four percent
of their assets in the first year of retirement, adjust that
amount each year for inflation, and the assets will last 30
years. This is good work that deserves applause, but like most
things in financial planning, it relies on assumptions which may
or not come true. It also assumes that humans are rational
non-emotional beings who will do exactly as expected year after
year. Thankfully, they are not. What a dull world that would be!

What to do?
Before cutting that retirement party cake, soon-to-be retirees
should figure out their spending needs and make sure they have
the income and assets to cover them. This has been stated many
times, but it can't be over emphasized. Write down all expenses
and don't forget the "special' expenses that don't happen every
day like vehicle and home repairs and those special vacations.
Take the time to do this right and run the numbers or hire a pro
to help. This isn't a budget. It's a spending plan and it's
healthy. Above everything else, financial success in retirement
is all about managing cash flow.

The next step is to figure out how much money is needed in each
of the next three years. This money should be invested in
something where the principal won't fluctuate like a money market
fund or certificates of deposit. Remaining funds should be
invested in a diversified portfolio of mutual funds that will
provide the desired balanced asset allocation.

Every year, repeat this exercise and liquidate enough money from
long-term investments to fund the new third year and rebalance
long-term investments. If those long-term investments are in the
"dumps," then delay this step until the following year when
investments recover. Just remember that delaying a year means
that two years of expected expenses will need to be liquidated.

This strategy is simple and flexible and it forces retirees to
review their spending and investments each and every year. It
allows for spending adjustments and helps avoid the need to sell
assets in an unfavorable market. Is it a "forever" strategy?
That's unlikely. Remember, times change and retirees must expect
to change with them. Financial planning is a process as opposed
to an event and retirees who understand that and prepare to be
flexible will find this special time much less stressful and a
lot more fun.

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